Description
Description: ACF is the largest independent sub prime finance co in the country and also operates in Canada and has about $15.5B in receivables. In terms of size, COF and Wachovia/Westcorp are actually bigger but their portfolios are much more focused toward prime credits. The company targets receivable growth of 15% with a range of 0-25%. ROE's are in the high teens with ROA's in the 2-3% range. The company's core business (about $12.5B of the portfolio) has 17% yields and 12% lifetime losses. Recently (the past year) the company added Long Beach Acceptance which has about 12% yields and 5-7% lifetime losses and was a direct competitor to Westcorp. ACF also bought Bay View (formerly CTL credit) which writes 84 month terms to prime borrowers and runs with 10% yields and 2% lifetime losses.
During the early 2000's, the company's stock collapsed as low as $2 (from $60) when it had liquidity issues as their static pools were cross collateralized (rising losses in one affected all and trapped cash) but that is not the case today. Today the co. has tremendous liquidity with $910M in cash on the balance sheet (it needs not keep more than $300M) and it has reduced the shares outstanding form 176M three years ago to 126M pro forma at Sept 30th with an ongoing buyback program. I estimate the shares outstanding will fall to 110M by Q4 2008 when the fully hedged convert expires.
Valuation: The stock is at $17. Tangible book is $15.84. However if the convert that expires in Nov. 2008 is excluded (it’s fully hedged) book is $17.40 and hence the stock trades at 1.0x adjusted book. The stock is 5.5x Q4 2008 EPS which I think is the key time period to look as because 10% of the float goes away at this point. (Shares outstanding go form an estimated 120M to 110M--there are 126M at Sept qtr end.)
The last 3 relevant deals (Onyx by COF, Westcorp by Wachovia, and Long Beach by AmeriCredit) have all gone at 12-14x forward EPS and 2.3-2.4x book which equates to a $40-45 take out on 2009 EPS for ACF. I continue to believe ACF has the most desirable specialty finance business that is still independent with 15% EPS growth, high teens ROE's, and 2-3% ROA's.
Recent trends: The last qtr was very good and credit quality was excellent. The company beat published and our EPS est. by a few pennies. However, the company lowered FY June 2008 est. from a $2.65-$2.85 range to $2.50-$2.75 range. We were always at the low end of the range and are still in the $2.60 range. The cut in estimates was primarily margin related due to the widening spreads in the ABS market. Credit is actually running slightly better than expected but we are entering the seasonally worse second half of the year and there is large seasonality in this business. Hence, at least optically, the next 4 months of data will look progressively worse and we are coming off very good vintages in the 04 and 05 origination years which performed better than expected. The December month and quarter will look the worst of all seasonally.
More specifics on credit: ACF plans in its core business for 12% cumulative static pool losses. (Long Beach and Bay View have lower losses of 5-7% and 2% respectively.) During the 2003/2004 vintage years losses actually got as low as 8% on its core product as both tighter underwriting, rising repo recovery rates, and a great economy helped reduce losses. 2006 static pools are trending toward 12%. The highest losses ever got to was 14-15% in the early 2000's but this was partially due to auction recovery rates plummeting from the low 50% range to the low 40% range fueled by massive selling of the auto rental companies fleets. Today, auction recovery rates stand in the low 50% range which are near an all time high. There is a close correlation between ACF's loss rate and the unemployment rate. Finally, ACF has been writing longer term business the past year and some have said this will lead to more losses. I am not as sure as longer terms means lower monthly payments which makes the vehicle more affordable.
For our estimates we have losses gradually going to 5.25% in q4 2008 from the current low of 3.29% but last qtr's 4.5%. Management has guided to 4-5% losses for the FY ending June 2008 so we are pretty much in line with guidance. The loss rate will be the key driver here. A 5.25% loss rate is about 14% lifetime losses on its core product or toward 2001 levels of losses.
Other key assumptions include a 20 bp decline in net interest margins this qtr and than stability, a slight improvement in G+A leverage as Long Beach and Bay View Servicing platforms are integrated (2.8% to 2.6% of assets, and 15% origination growth - management has guided to a range of 0 to 25% growth).
The securitization market and margins: I have great confidence ACF will do a securitization at reasonable spreads at the end of Sept and it will be a big positive for the stock. ACF did a deal in Oct 1999, the 2nd company to do so after Chrysler. The auto ABS market is very liquid and if ACF did a deal now they said it would be at 70 bp over the 2 year--all in. (The range over the past 15 years is 35-70 bp.) However, the 2 year has come in 60 bp (the relevant index) from 4.8% to 4.2% since August 1st. Moreover, ACF is RAISING RATES by at least 30 bp and the price increases are being followed by other players (COF and Wells--C and HSBC are cutting back). Hence, I actually think there will be little margin compression and the widening ABS market will turn out to be a big positive to the tune of 50 bp.
Huge insider buying: Clifton Morris bought 168K shares or $2.8M last week. He never buys and is retired.
Catalyst
The last 3 relevant deals (Onyx by COF, Westcorp by Wachovia, and Long Beach by AmeriCredit) have all gone at 12-14x forward EPS and 2.3-2.4x book which equates to a $40-45 take out on 2009 EPS for ACF. I continue to believe ACF has the most desirable specialty finance business that is still independent with 15% EPS growth, high teens ROE's, and 2-3% ROA's.